Supply Chain Digest has written a couple of times this year about the potential impact of skyrocketing oil costs on supply chain strategy. That includes comments from Supply Chain Digest editor Dan Gilmore on $100 Oil and the Supply Chain, and a more recent piece on Supply Chain Network Design in an Era of Dynamic Costs.

In the end, as Gilmore noted, an environment of dynamic costs puts a premium on agility. “At the end of the day, what it says to me is that flexibility is simply more necessary than ever,” Gilmore wrote. “Let’s all hope we’ll never see $100-$200 a barrel oil, but you sure better have a plan if we do.”

But just how to you build a flexible supply chain network?

One of the experts cited in the latest column is Mike Kilgore, president of ChainAlytics, a supply chain strategy consulting firm. Kilgore agreed to share with Supply Chain Digest his recommendations for building a supply chain network strategy that provides maximum flexibility and can optimally respond to changes in external costs.

Kilgore’s recommendations for building a flexible supply chain network are summarized in the table below.

Strategy

How it Builds Supply Chain Agility

Continuously Plan Your Supply Chain Network

Frequent analysis in an environment of rapid change promotes an agile SCM culture

Evaluate a Range of Supply Chain Network Alternatives

The mathematically optimal supply chain network may not be the best choice when risk/potential change is considered

Limit Exposure to Cost Fluctuation

Use hedging and other strategies to lock down costs

Use Outsourcing to Implement Flexibility

Locations “sensitive” to cost changes should often be outsourced to enable rapid re-optimization

Spreadsheet-based models or other less sophisticated tools make it much harder to evaluate multi-scenarios when planning

Continuously Plan Your Supply Chain Network

Traditionally, firms have treated supply chain optimization as a strategic event run every two to five years, until a major corporate event occurs, like an acquisition, or “the pain is so bad they can’t stand it”.

This periodic analysis does deliver significant value; a firm typically will reduce the operating expense in scope by 5-15% upon implementing a supply chain network redesign. Despite the significant initial operating improvements, results often begin to deteriorate within months. Why? Firms operate in a dynamic environment, where constant change threatens to create new imbalances within their supply chains.

Kilgore says that in order to sustain the value provided by sophisticated analysis, firms need to conduct continuous rather than sporadic planning efforts. Continuous analysis enables companies to accelerate decision-making, view the supply chain holistically, and answer ad hoc questions with fact-based analysis.

SCDigest notes that while a small number of companies, such as Pepsi/Frito-Lay, have taken this approach to continuous supply chain network planning and achieved very positive results, they are the exception, at a time when it is more necessary than ever given today’s dynamic corporate strategy and cost environment.

Evaluate a Range of Supply Chain Network Alternatives

The supply chain is designed around a set of tradeoffs, such as fixed versus variable costs, and transportation versus inventory costs. When evaluating supply chain design, companies can’t focus solely on the mathematical optimal. Instead, firms need to evaluate the “Range of Indifference” -- the set of alternative designs that have similar cost and service performance but different levels of risk. By evaluating this range of alternatives, companies can understand the concentration of risk in activities that are more vulnerable to major swings (e.g., energy and transportation costs) versus costs that are more likely to change in a slow, sustained manner (e.g., labor costs).

Limit Exposure to Cost Fluctuation

Most companies create a five-year network plan, but can’t wait five years to re-evaluate the network because cost changes are too extreme. By creating an annual five-year plan, firms can continue to evolve their network plan, but they still should limit their cost exposure until they can reconsider the impact of cost changes. Kilgore suggests, for example, considering the use of hedging strategies on commodities like energy, fuel, and interest rates. In this way, companies can stabilize costs until the next planning horizon. Firms can also use contracts with carriers and suppliers to lock in same-year pricing until they can reconsider the cost impacts and available alternatives.

Use Outsourcing to Implement Flexibility

Some locations are highly sensitive to changes in cost structure, while other locations are clearly going to stay in the network regardless of the scenario, Kilgore says. Understanding this sensitivity can lead to strategies that improve flexibility. The “cost sensitive” locations often come in and out of optimal network designs as costs change. Firms should consider outsourcing these sensitive locations, thus ensuring they can gain and eliminate capacity quickly. Companies can also employ a hybrid strategy to create flexibility for more stable network locations – using outsourced labor to increase/decrease the workforce and facility lease terms to expand or contract capacity.

To effectively evaluate all of the network alternatives, firms must consider millions of possible combinations – far too complex for a simple spreadsheet. In order to consider the ‘what-if’ alternatives of a network, firms need to invoke network optimization and simulation tools used in conjunction with transportation modeling or inventory optimization to create the optimal scenarios.

What would you add to this list of strategies for creating flexible supply chain networks? How important are supply chain network optimization tools in achieving flexibility? Let us know your thoughts?